Borrowing against a 401(k): a very bad idea

×

As the threat of foreclosure continues to mount for many homeowners, the temptation to borrow against a 401(k) increases. Very bad idea, yet one that occurred to 13-19% more 401(k) holders in 2007. A recent article in CFO Magazine details a few of the ugly scenarios that can result.

Yes, many companies offer loan programs as part of their 401(k) programs as an incentive to get employees to participate. Employee loans against 401(k) balances are bad for both employers and employees. Not only is it a huge administrative headache for employers, but employees often get caught if their are any discrepancies or inaccuracies in the amortization schedule for repayment. Like the IRS will care that someone in the HR department made a mistake. The employee is solely responsible for any and all payback irregularities.

One of the advantages of participating in a 401(k) program is to take advantage of the free money from matching employer contributions as well as compound interest on contributions. Neither of these advantages occur when an employee stops making new contributions and merely repays the borrowed amount. Problems mount exponentially if an employee loses his or her job while owing money against the 401(k) balance. Just when the employee is most at financial risk, the outstanding amount must be repaid in full or the IRS will consider the loan or withdrawal as ordinary income and tax it accordingly. There is a 10% penalty if the borrower is under age 59 1/2.

The IRS does allow for hardship withdrawals from a 401(k) to avoid foreclosure of a primary residence, but the long term savings consequences are staggering. A 5 year, $8,200 loan can have a $62,000 impact on the 401(k) bottom line. Cutting expenses, renegotiating with creditors, getting a second job, are just a few of the much better alternatives for financially strapped homeowners.


Increase your money and finance knowledge from home

Managing your Portfolio

Keeping your portfolio and financial life fit!

View Course »

Goal Setting

Want to succeed? Then you need goals!

View Course »

TurboTax Articles

What is Schedule F: Profit or Loss from Farming

If you earn a living as a self-employed farmer, you may need to include a Schedule F attachment with your tax return to report your profit or loss for the year. The Internal Revenue Service defines ?farmer? in a very broad sense?whether you grow crops, raise livestock, breed fish or operate a ranch.

5 Tax Tips for Single Parents

Filing taxes as a single parent requires coordination between you and your ex-spouse or partner. Usually the custodial parent claims the child as a dependent, but there are exceptions. A single parent is allowed to claim applicable deductions and exemptions for each qualifying child. Even though you claim your child as a dependent, she may still have to file her own tax return if she has income, such as from an after-school job.

Add a Comment

*0 / 3000 Character Maximum